Bull Run

March 22, 2004

WE ARE TOLD we live in the New Economy, an economy of computers and fiber-optic cables, capital without borders, and competition on a global scale. This is mature market capitalism, and its promise for human advancement—when combined with democracy and individual freedom—is rightly touted at every turn. But, if our economy is a creature of the twenty-first century, our thinking about government’s role in the economy is mired in the nineteenth.

Two essentially opposite viewpoints dominate today’s debate. On one side are those who see market capitalism, loosely regulated and unencumbered by the artificial interventions of government, as perfection itself. They argue: Leave the markets alone, let them work, and efficiency, choice, and progress will follow. On the other side are those who argue that, as miraculous as the capitalist experiment has proved to be, free markets cannot be left unchecked. To maintain a just and equitable society, they say, markets must be protected from their natural tendency toward excesses that lead to monopolies and unfairness. In this scheme, government’s role is to put the brakes on capitalism and to protect the public from market forces through its power to tax and regulate.

This conflict has often been reduced to caricature—heartless laissez-faire capitalists versus meddling government bureaucrats. But this characterization presents a false choice. If there is one lesson that can be gleaned from the New Economy, it is that the government’s proper role is neither that of passive spectator nor lion tamer. The proper role of government is as market facilitator. Government should act to ensure that markets run cleanly as well as smoothly. It should prevent market failures and right them when they occur. And it should ensure that markets uphold the broad values of our culture rather than debase them. In this vision, government action is necessary for free markets to work as they are intended—in an open, competitive, and fair manner. In this vision, government helps to create, maintain, and expand competition, so the system as a whole can do what it does best: generate and broadly distribute wealth.

Where government has retreated from these core responsibilities, economic dislocation and decay have followed. Three recent examples make the point. We have chosen them not because they are the only or even the best available but because they reflect our practical experience over the past five years in New York state and because they illustrate three distinct rationales for market intervention: to enforce the rules to deal with market failures, and to uphold core American values. They show that the Bush administration’s economic approach, while veiled in the rhetoric of free markets, actually subverts them. True free-marketers understand that free markets operate according to principles that must be enforced. But President George W. Bush has abdicated his responsibility to protect our markets, leaving a vacuum in which market failures are ignored or chalked up to "natural forces" and the economy suffers shocks that could have been avoided or corrected by careful government intervention. By advocating smart government action and shifting the rhetorical paradigm, Democrats can provide voters with a coherent, pro-market justification for the policy objectives we share. It’s good policy and good politics at the same time.

GOVERNMENT HAS BEEN effective and well-received when it has acted to preserve (or restore) confidence in the fairness of the market itself. At a basic level, for a market to be truly free and efficient and have the full confidence of its participants, two things are required: integrity and transparency. Integrity, in this context, is the idea that actors in the marketplace are what they purport to be: that those who claim to offer independent advice and analysis are not tainted by conflicts of interest; that those who are entrusted with protecting shareholders do so, rather than enriching themselves at shareholders’ expenses; and that those who, by virtue of their wealth, power, or access, may be positioned to violate the rules do not. In a system where there is not, and cannot be, a cop on every metaphorical street corner, we rely on this integrity to give us confidence that the system is fair and genuinely competitive.

Just as actors must be what they claim to be, information in a free market must be accurate and truthful, freely flowing, disseminated in a timely way, and available to all. Transparency—implemented through disclosure requirements, institutional barriers to abuse, or widely accepted rules of conduct—is what makes meaningful choice possible. And choice by all actors in a rational market- -be they investors or consumers, CEOs or shopkeepers—is what creates the competitive pressures that make the market more efficient and create wealth for us all.

Government is the institution best-suited to protect against corruption and abuse and to ensure that the economic playing field is level. But, in the 1990s, Wall Street experienced what can only be described as the "perfect storm" of government failure. It began with the consolidation of the financial-services sector—permitted by the repeal of the Glass-Steagall Act, a Depression-era statute requiring that commercial and investment banking be separated. The result was the formation of vast full-service enterprises that brought together many potentially conflicting lines of business, including commercial banking, investment banking, stock analysis, and retail brokerage. At the same time, we democratized the marketplace by (wisely) encouraging the American public at large to invest in the capital markets. The interface between mega-institutions and small investors was fraught with risk—risk met by a regulatory void. Indeed, Harvey Pitt, the first Securities and Exchange Commission (SEC) chair appointed by Bush, is a former industry lobbyist who promised the financial sector a "kinder, gentler SEC," an approach that led to a total breakdown in market enforcement. From Tyco to Enron to mutual funds to analyst compensation, the SEC simply was not attentive to the structural failures that were widely known to industry insiders.

With protections against conflicts of interest severely hobbled, integrity and transparency were soon sacrificed. As a result, research analysts whose compensation and career prospects depended upon the fortunes of their investment-banking partners pushed information about companies that was not just "imperfect," but false. In one infamous example, Merrill Lynch analyst Henry Blodget simultaneously helped pitch banking business to InfoSpace, a Web search company, and hyped the stock to investors, all the while telling his co- workers that the stock was a "piece of junk." In relying on corrupted advice like this, investors invested, corporate executives and investment bankers got rich, and companies that should have been market losers actually "succeeded."

But that success, which took the form of skyrocketing stock prices, options values, and compensation packages for corporate executives, was necessarily short-lived. The market had its revenge, as artificially pumped-up companies were unable to compete over the long term. Their business models failed and their stock prices plummeted. And yet abuses continued. Despite WorldCom’s sinking fortunes, Citigroup analyst Jack Grubman kept promoting the stock, all the while receiving compensation that resulted from WorldCom’s banking business with Citigroup. But, ultimately, he couldn’t keep reality from catching up to WorldCom: Its share price dropped from $60 to 20 cents, wiping out $100 billion in market value.

The real victims were the companies’ employees, the investing public, and the market itself. Not only had the public confidence essential to market performance been squandered, but the companies into which huge amounts of capital had been funneled were, from a long-term perspective, the wrong ones. Inefficient, unsound, and simply undeserving, these businesses failed to create meaningful jobs, growth, or lasting wealth. Couple these structural failures with the impact of other corporate scandals—such as Enron, Tyco, and Adelphia— and the result was grim. When the bubble burst in the late ’90s, and the truth about overhyped companies came to light, stunned investors experienced the biggest drop in the S%amp%P Index since the 1987 market crash—a drop with profound ripple effects throughout the national economy. A recession that was perhaps inevitable was deepened, and individuals who had set aside assets for education or retirement suddenly found these assets diminished or wiped out entirely.

So much had gone wrong in so short a time that government’s ability to right the economy was limited. That said, the forceful reassertion of government’s role as facilitator of the twin values of integrity and transparency has contributed powerfully to a sense that we are beginning to put our national economic house in order. With the acceptance of industry-wide codes of conduct by financial-services companies, new and more stringent disclosure and certification requirements under the Sarbanes-Oxley Act, and the aggressive policing of segments of the marketplace, the decline in investor confidence has been halted and perhaps even reversed.

GOVERNMENT CAN ALSO help facilitate the smooth functioning of markets when they are unable to appropriately distribute costs. The burdens of pollution provide a classic example. Where the market finds itself unable to allocate pollution costs efficiently and fairly, and where the federal government refuses to act, the intervention of others, including state governments like New York’s, has become necessary.

Take air pollution in the Northeast caused by coal-burning power plants in the Midwest. Corporate players, acting in their rational self-interest, have failed to bear or equitably spread the costs associated with their activity. Instead, they have shifted those costs to others, for whom there is no market recourse. In this case, the costs were acid rain and airborne pollutants, and their devastating effects on the environment and human health—not in the Midwest, where the plants generate and sell their energy, but hundreds of miles downwind, in the Northeast. Plant owners had purposely built smokestacks tall enough that pollutants would fall not on their consumers or those nearby but, quite literally, into someone else’s backyard. The costs have been dear. Thousands of New York children suffer from asthma that is at least partially attributable to pollution sent East from power plants in states like Kentucky, Ohio, and West Virginia. And even the Bush administration’s Environmental Protection Agency admits that, in New York’s Adirondack Mountains, hundreds of lakes have acidity levels that could kill off certain aquatic species.

In a perfectly functioning market, the costs imposed by this conduct would be borne either by the producer in the form of reduced profits or by the consumer in the form of higher prices. Such costs would not be dumped on the doorstep of those who don’t benefit from cheap Midwestern energy. But that is precisely what is happening: Northeasterners have been left holding the bag, and the market alone offers them no way to respond. They are stuck— unless and until government intervenes.

Alas, the Bush administration has refused to do that. Even as it spouts the rhetoric of free-market efficiency, the White House has allowed the polluters to avoid bearing the economic and health-related costs they have imposed. It has tried to reverse a long-standing interpretation of Clean Air Act regulations, which require power plants and other industrial facilities to install modern pollution controls when they are upgraded. This shift in environmental policy represents an abandonment of the market principle that costs should be borne by those who consume or pay for the product—an abandonment driven by a desire to benefit the energy industry. Indeed, the connection between administration policy and interest-group politics is direct and explicit: The shift in the Clean Air Act’s interpretation— undertaken to protect Midwestern polluters from having to make expensive upgrades—grew directly out of Vice President Dick Cheney’s industry-dominated Energy Task Force, through which energy producers effectively dictated the very policies that are supposed to regulate them.

Left with no other choice, the states and citizens suffering from Midwest- generated pollution have gone to court and successfully stopped the administration’s attempted policy change. The point of this effort is neither to limit the availability of cheap energy to Midwest consumers, nor to shift the costs to them simply for the sake of doing so. Rather, it is to ensure, as an efficient market must, that the costs are borne by the parties responsible. Only by placing the costs where they belong can the market system as a whole assess whether the product is being efficiently created and appropriately priced vis—vis potential competitors. That is when the market, freed from its own failures, really works.

LASTLY, OUR COMMITMENT to market capitalism cannot obscure one glaring and immutable fact: that, in a number of important ways, an unregulated market does not safeguard certain core American values. That’s why our government—with broad bipartisan support—has instituted child-labor laws, minimum wage laws, anti-discrimination laws, and certain safety net protections designed to ensure that people do not fall below a basic level of sustenance. There is little debate today about the value of these measures. They are, in essence, what we are all about. Child labor is not forbidden in this country because it is inefficient (although it is); it is forbidden because it is wrong.

Unfortunately, our belief in the importance of equal opportunity and nondiscrimination is too often forgotten when it comes to the debate over whether and how to police the market for home mortgages. In poor and working- class communities across the nation, predatory mortgage lending has become a new scourge. Predatory lending is the practice of imposing inflated interest rates, fees, charges, and other onerous terms on home mortgage loans—not because the imperatives of the market require them, but because the lender has found a way to get away with them. These loans (which are often sold as refinance or home-improvement mechanisms) are foisted on borrowers who have no realistic ability to repay them and who face the loss of their hard-won home equity when the all-but-inevitable default and foreclosure occurs. When lenders systematically target certain low-income communities for loans of this sort, as they often do, the result is more insidious. Costs are imposed and burdens inflicted in a manner and to a degree that is discriminatory by race.

On the surface, predatory lenders are doing nothing more than seizing a "market opportunity" for refinancing or home-improvement loans in lower-income communities. To be sure, such communities desperately need credit. And it stands to reason that the prices and terms will be less favorable to borrowers whose financial circumstances are troubled or limited. In this sense, predatory loans are the natural outcome of a competitive market. In a policy debate bereft of values, this market rationale becomes a value unto itself—and values like equal opportunity disappear.

But, in our system, the market is there to serve our values, not the other way around. As study after study has shown, the overwhelming majority of people who fall prey to predatory loans would be better off with no loan at all. Moreover, borrowers in this category often bear the same or similar financial characteristics—income levels, credit-worthiness, ability and willingness to repay—as their counterparts in the prime market. As a matter of economics, they actually qualify for good loans at good rates. What distinguishes them from borrowers who get credit at the right price, on the right terms, is their actual and perceived lack of options, their limited financial savvy, and, too often, the color of their skin—and sometimes their age or gender.

For a society devoted to fairness and nondiscrimination—as well as the quintessentially American goal of homeownership—the prices, terms, and overall economic impact that we see in predatory home mortgage loans cannot be justified. They are just plain wrong. And, quite apart from the values issue, it is difficult to imagine a less rational, less efficient economic practice than lending of this sort. At the micro-level, it results in a gross misallocation of costs—imposing higher costs than the market requires on those least able to bear them. At the macro-level, it denies lower-cost capital to whole classes of persons who would otherwise qualify for it and to neighborhoods whose economic vitality depends on it.

In these circumstances, government must step in to curb predatory lending and encourage the flow of fairly priced capital to sectors where it is needed and will be well-used. Filling a gap left by federal inaction, state enforcement efforts in this arena have centered on identifying the valid economic criteria considered in mortgage underwriting and compelling lenders to focus on those factors—not on preconceptions, prejudices, or predatory instincts—in determining how to price home mortgage loans. The point is not to protect people from their own bad decisions or, conversely, to guarantee that mortgages be granted to specific persons or groups on specific terms—that would violate the principle of market freedom. The point is to support equal opportunity and to ensure that borrowers are charged rates and fees based upon their status and qualifications as economic actors in the mortgage market, not upon their diminished access or market savvy or their race. In taking action of this sort, state government regulators have upheld core national values and facilitated a fair and open market at the same time.

The Bush administration’s reaction has been swift, predictable, and negative. The Treasury Department’s Office of the Comptroller of the Currency has issued regulations stripping states of authority to stop predatory lending. It claims that continued state enforcement and regulatory authority will interfere with federal efforts to "regulate" national banks and, of course, with the free market in credit. In truth, the yawning gap between federal rhetoric and federal action in this area suggests a different rationale. Far from seeking to preserve federal prerogatives to regulate or to protect the market from state meddling, these efforts smack of a surrender to banking interests at the expense of market efficiency and the people capitalism is intended to serve.

IN A PERIOD of severe budget constraints, complex and shifting global entanglements, and a failure of political will, one of our most difficult choices concerns what role government should play in an economy that on the whole has proved astonishingly durable, efficient, and successful. It is a choice we must make as members of a democratic polity, as citizens of a global economy, and as Democrats for whom the old answers no longer satisfy.

President Bush has helped frame that choice. By pursuing policies that are cloaked in free-market rhetoric but fail to facilitate fair markets, he has surrendered to corporate constituencies. He has shown that his party’s rhetorical attachment to free markets is just that—a rhetorical attachment and nothing more. And he has done so at a time when it is clear that government nonintervention leads not to market freedom and a rising of all boats but to unrestrained corporatism, gross market distortions, inequitable accumulation of wealth, and economic stasis.

In trying to articulate a more constructive vision—one that is both fiscally and economically sound and that makes sense to the average American voter—Democrats should promote government as a supporter of free markets, not simply a check on them. Government action must be justified by its ability to define, catalyze, and facilitate the market’s core mechanisms; to prevent it from faltering under the weight of its own imperfections; and to uphold the underlying values to which the system is, or ought to be, dedicated. It is a vision consistent with trust-busting and other progressive market measures first enunciated early in the last century by Theodore Roosevelt, who said, "We grudge no man a fortune which represents his own power and sagacity, when exercised with entire regard to the welfare of his fellows."

By taking up the mantle of efficient, forward-looking, and market-oriented government action, Democrats can move from being a party that simply opposes Bush’s tainted version of laissez-faire to one that advocates for the progress that comes with real market freedom. It is a powerful argument, a true argument, and it is ours for the making.

Eliot Spitzer is attorney general of the state of New York. Andrew G. Celli Jr., a lawyer practicing in New York City, served as chief of the Attorney General’s Civil Rights Bureau from 1999-2003. This article appeared in the March 22, 2004 issue of the magazine.